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'Size and quality of banking opportunity in non-urban India is highly under-appreciated'

Last updated on: July 10, 2013 13:31 IST

Conditions laid down by India’s central bank will be challenging for those seeking a bank licence, says Aashish Agarwal, below, left, the Mumbai-based head of research at brokerage firm CLSA Ltd.

Rural markets can provide 25 per cent growth over the next decade and improve profitability of banks, he tells Rediff.com's Faisal Kidwai in an interview.

Could you tell us a bit about why the Reserve Bank of India is inviting business houses and State-run companies to set up banks?

In our view, the RBI wants to offer the licences in a fair and proper manner to people who can scale up banking business and reach out to unbanked markets. Licences will be granted based on the applicant’s performance over the past decade and to those falling within the ‘fit and proper’ criteria.

Some are saying the stringent conditions, such as keeping 27 per cent of deposits at the RBI and in government bonds and having one in four branches in rural areas, mean new banks will find it difficult to be profitable. What's your view?

The norms on priority sector lending, reserve requirement and rural branch opening will be a challenge for new banks. NBFCs (non-banking financial companies) may find it tougher as compliance with these norms will impact their existing ROA (Return on Assets) negatively. However, in the longer term it will help them access retail deposits and increase leverage that will provide support to ROE.When nationalised banks have been unable to bring the non-banking population into the fold, how hopeful are you that new banks will succeed?

Banking penetration in rural India has improved over the past decade and data from the Census shows that. New banks that are oriented to serve the non-urban

India are expected to bring fresh ideas to financial inclusion and rural banking. We believe that the size and quality of banking opportunity in non-urban India is highly underappreciated.

In our recent report, New Main Streets, we have highlighted how the non-urban markets can deliver nearly 25 per cent compounded growth over the next decade and help banks to improve profitability. We believe that not only profitability of these markets, but also changes to regulations, improvement in technology and access to market information are supporting it. In this report, we have discussed how new markets, new products, new technology and new customers can drive a successful expansion in non-urban markets.

Non-performing assets are becoming a big problem for many banks. What should be done to bring down NPAs?

Asset quality is a problem that arises from a combination of (1) slowdown in economic growth, (2) pressure on borrowers and (3) weakness in banks’ underwriting / recovery mechanisms. Therefore, any improvement in the asset quality of banks will reflect improvement in these three fundamental drivers. We believe that some of the important steps that the government has taken regarding power projects and fuel availability will be key to controlling this problem.

What are some of the major problems facing the banking sector in India?

Some of the key problems facing the banking sector in India are:

i) Capital adequacy -- the new Basel guidelines will require banks to shore up their capital bases and this will be a challenge for the sector, especially for PSU (public sector undertaking) banks as their capital adequacy has been low.

ii) Employee costs for PSU banks -- New wage settlement for PSU banks is a key risk on their profitability. While banks have been factoring in a 15 per cent hike, bank unions have asked for much higher hike. We believe that a combination of rise in costs and pressure on margins can have serious impact on the profitability of some of the smaller PSU banks which don’t enjoy a great deposit franchise.